5 Reasons Small Businesses Fail in Their First Year

Small Business
5 Reasons Why Small Businesses Fail
Why Small Businesses Fail

Alexey Sokolin: Businesses sometimes “focus too much on infrastructure and inventory.”

Starting a small business is tough, but growing one — or just keeping it afloat — is even harder.

Even though more than 500,000 small businesses are created each year in the U.S., only half of them survive past their fifth year, according to the U.S. Small Business Administration.

Many small businesses don’t even make it past their first year. NerdWallet spoke to small-business leaders and experts to find out some of the main reasons why.

1. Flawed (or nonexistent) market strategy

5 Reasons Small Businesses Fail

Chris Ayala: “If you don’t know who you’re selling to, you’ll start off in a bad place.”

“If you don’t know who you’re selling to, you’ll start off in a bad place,” says Chris Ayala, CEO of Alcohoot, maker of a smartphone-based Breathalyzer device.

That’s precisely what happened at Alcohoot, which initially aimed its product mainly at millennials. Sales went nowhere.

It was when the company pivoted to a different market, mainly parents and older adults, that the product gained traction, Ayala said.

“Just because it’s a cool product, it wasn’t going to sell itself,” Ayala says.

Keenan Baldwin, chief operating officer of SiteZeus, which uses technology to help companies find the best physical locations to set up a business, says many entrepreneurs “fail to understand who their ‘target’ customer is.”

Alexey Sokolin, chief operating officer of Vanare, a wealth management services company, agrees, saying small businesses often don’t make it because they “do not focus on product/market fit … and instead focus too much on infrastructure and inventory.”

2. Misguided optimism

Why Small Businesses Fail

Rob Hackel: “Taking your time to truly confirm a need is unmet can make things considerably easier in the long term.”

Why do some small businesses fail?

Optimism!” says Rob Hackel, chief operating officer of investment services company R.F. Lafferty & Co.

Huh?

Well, while it’s generally smart to be optimistic when starting a business, what “seems to be a positive trait” can turn into “a hindrance to a successful launch,” he says.

That’s because some entrepreneurs fantasize about a “Field of Dreams” ending as they start a business. “If you build it they will come,” Hackel quips, referring to the famous line in the Hollywood movie.

What can happen is that “you believe a product or service will work, but the market does not,” he says, and in such cases an “overly optimistic outlook” can work against you.

“Taking your time to truly confirm a need is unmet can make things considerably easier in the long term for any small business,” Hackel says.

3. Broken finances

Why Small Businesses Fail

Stephen Sheinbaum: “Leave plenty of room in the budget for the unexpected.”

Having a clear financing plan is a no-brainer, but some small-business owners plunge in without a clear idea where the money to start or sustain their business will come from.

“It is not uncommon for a restaurant to sign a lease and expect to be open within a month or two and then find itself facing a three-month wait for the necessary operating permits,” says small-business funding expert Stephen Sheinbaum, who is the founder of Bizfi.com and Merchant Cash and Capital. “It has rent to pay and other expenses, but nothing is coming in.”

That’s why entrepreneurs must map out all their expected expenses for the first year — rent, electricity, office supplies and marketing — and “leave plenty of room in the budget for the unexpected,” he says.

Joe Franklin, president of Franklin Wealth Management, points to small businesses that are “underfunded or run out of capital due to poor planning or unforeseen circumstances.”

“Business owners should learn to be frugal, working on a lean budget and continually watching costs, especially in the early going,” Franklin says.

4. Having a bad team in place

Why Small Businesses Fail

Keenan Baldwin: Many entrepreneurs “fail to understand who their ‘target’ customer is.”

“Human capital is one of the most important pieces to running and growing a business,” Franklin says.

You may be a one- or two-person team in the beginning, but eventually you would need more people to cope with that growth. “The first few hires are critical in establishing a good culture,” Franklin says. “A bad hire can ruin a small business.”

In fact, Hackel of R.F. Lafferty & Co. says, “It is more time-consuming and expensive to rehire than it is to hire properly in the first place.”

Hackel adds: “Any small business that is just starting out needs a full commitment to the business, and a small-business owner that is constantly hiring staff members will easily have their eye off the ball. Remember, hire slowly and fire quickly.”

5. Lack of stamina and a long view

Why Small Businesses Fail

Sandy Betner Chaikin: “Small-business owners need to have the cash flow and stamina to survive in those early years.”

Starting and growing a business is like running a marathon.

Franklin of Franklin Wealth Management says a small business can fail because the people behind it sometimes don’t invest “enough sweat equity.”

“Starting and running a business is tough work, especially in the early stages,” he says.

Sandy Betner Chaikin, co-founder of Chaikin Analytics, a mobile stock research platform, notes that it typically takes four years “to really build a business.” “So small-business owners need to have the cash flow and stamina to survive in those early years,” she says.

Small-business success, says Craig Goos, managing director at North Capital, an investment advisory firm, “can be obtained if you are patient, willing to work hard, and stay focused.”

Benjamin Pimentel is a staff writer covering small business for NerdWallet. Follow him on Twitter @benpimentel, on Google+ and on LinkedIn. Contact Ben at bpimentel@nerdwallet.com

For more information about how to start and run a business, visit NerdWallet’s Small Business Guide. For free, personalized answers to questions about starting and financing your business, visit the Small Business section of NerdWallet’s Ask an Advisor page and NerdWallet’s Best Business Loans page.